Short run production theory

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Short run production theory

  1. 1. Short run production theory
  2. 2. Factors of Production What is production? It is easiest to imagine the production process as a factory which turns inputs (the factors of PRODUCT production) into outputs (a product). However, the theory of production also includes businesses which simply trade (i.e. buy and sell) without actually making anything, and businesses which deliver a service as well as those which sell a tangible product. All these businesses use land, labour and capital, with a dash of entrepreneurial-ism, to meet a defined need, hopefully at a profit! Further more, these business enterprises can be privately or state owned. So although we often use factory examples, remember how broad the theory actually is.
  3. 3. The importance of time And...7. Short-run 8. Long-runRevenue and costs in the short Revenue and costs are not run are influenced by the restricted by factors of factors of production available. production in the long run. Short-run is defined as a Long run is defined as a period period within which at least one over which all the factors of factor of production is fixed. production can change.If we run a factory (or coffee shop, hospital, airline, etc.) time makes a big difference tohow we think about production. In the short-run, we are limited in what we produce bythe size of our factory and the equipment we own. We can employ new workers fairlyeasily, and buy more materials, but there is only so much we can produce every day.The question is “What is the optimal level of production?”In the long-run anything is possible. We can raise finance and buy more factories, aswell as employing more workers and buying more materials. The question thenbecomes “What is the optimal scale of production?”
  4. 4. The optimal level of productionWhen one person makes a product they have to do everything, from start to finish. When two people share the Adam Smiths pin factory work they can divide up the tasks and begin to specialise in Over 200 years ago, Adam Smith argued certain aspects of production. that the production of a simple pin could be shared amongst many As more people are employed workers. in production the job of making the product can be broken “One man draws out the wire, another straights it, a third cuts it, a fourth down into more and more points it, a fifth grinds it at the top for specialised tasks. You may be receiving the pin head. The business surprised just how many stages of making a pin is divided into about there are to the production of eighteen distinct operations.” even the simplest of products.
  5. 5. How does specialisation improve productivity?The division of labour, as Adam Smith called it, could significantly increase the output of a firm in three ways: How significant is the division of labour?II. The increase in dexterity of each “A workman not educated in the business worker of pin making could scarce, perhaps, with his utmost industry, make one pinIII.The saved time by avoiding in a day... Ten persons could make moving from one job to another among them upwards of forty-eight thousand pins in a day. Each person,IV.The invention of machines which therefore, making a tenth part of forty- could perform the simple tasks in eight thousand pins, might be place of workers considered as making four thousand eight hundred pins in a day.”The application of these ideas has revolutionised production and dramatically increased our wealth and standard of living.
  6. 6. Toasters and the modern economy How far has the concept of division of labour taken us? Thomas Thwaites has the answer. Thomas asked himself, how hard could it be for one man to build a toaster, from scratch? One factory can turn out hundreds, if not thousands, of toasters every day. How much greater is this than what one man could do alone, without the benefit of the division of labour?
  7. 7. Strawberry’s and specialisationIf you have ever been strawberry picking you will know that you need one field of strawberries, one basket and a lot of effort.How many distinct operations can the process of picking strawberries be divided into? Include everything from finding the ripe strawberries through to weighing and packing them Think about what equipment you could use
  8. 8. Handling production dataNo. of workers 0 1 2 3 4 5 6 7 8 9(fixed capital)Total output, 0 1 4 9 16 25 32 35 36 34product or returnsAverage output, - 1product or returnsMarginal output, 1 3product or returnsHere we have some data which shows the total output of a firm in the short run as itemploys more labour to work in its factory. By calculating the average output per workerwe can see the effects of increased productivity due to specialisation. The marginaloutput is the amount added to total output as each additional worker is added.Fill in the missing data for average and marginal output.
  9. 9. Short-run production theoryNo. of workers 0 1 2 3 4 5 6 7 8 9(fixed capital)Total output, 0 1 4 9 16 25 32 35 36 34product or returnsAverage output, - 1 2 3 4 5 5.3 5 4.5 3.8product or returnsMarginal output, 1 3 5 7 9 7 3 1 -2product or returns What happens to average and marginal output as more workers are employed? Why? Plot the total output on one graph and the average and marginal output on another graph.
  10. 10. Product curvesWe can see the effect of the division of labour in these curves as total, average and marginal product rises.However, we also see something strange happening. As more workers are employed the increase in total product begins to slow, then actually falls as the ninth worker is employed. The marginal product curve shows that the ninth worker has a negative marginal output... by increasing workers to this level the firm actually produces less.What is going on?
  11. 11. The law of diminishing marginal returnsThis law states that as a variable factor of production is added to fixed factors, eventually the marginal returns (or marginal product) of the variable factor will begin to fall.Imagine our strawberry pickers. As moreworkers are employed the total output (no.of strawberries picked) increases, but sodoes the marginal output as each workermakes the operation more productive.However, the filed is only so big and canonly yield so many strawberries. As thenumber of workers increases further themarginal product falls. Workers get ineach others way and reduce each othersproductivity.
  12. 12. Drawing the marginal and average product curves Note the relationship between the marginal and average product curves:  When marginal > average product the average rises  When marginal < average product the average falls  When marginal = average the average is constant In other words, the marginal product curve crosses the average product curve at its highest point.
  13. 13. Summary Short-run production theory attempts to explain what happens to output as a variable factor is added to fixed factor/s of production As a variable factor of production is added to fixed factor/s the marginal output increases at first due to the effects of specialisation and the division of labour As the variable factor continues to be added the marginal product eventually falls due to diminishing marginal returns